The Tax Hike Silver Lining

By Robert Milburn

Fidelity Charitable runs the largest donor-advised fund program in the country, with $10.1 billion in assets under management parked in clients’ IRS-approved charitable vehicles. The charity business is suddenly smoking. Fidelity clocked a 33% increase in dollars granted to charities from its donor-advised funds, for a total of $919 million, alone during the first half of 2013. In comparison, Fidelity saw a 14% increase in charitable grant-giving during the same period last year.

There’s much more going on here than just an improving economy. What we are seeing is the unintended consequences of increasing taxes on the wealthy. The squawking by Congressional Democrats last year – about the affluent paying their fair share of taxes – ultimately caused donors to front-load their charitable contributions. By making the donations immediately, they could reduce their taxable base before the inevitable tax increases bit. In 2012, for example, Fidelity saw a 24% increase overall in donor-advised fund contributions, 20 percentage points of which it attributes to the heated fiscal cliff negotiations.

There’s a good reason for this. A donor-advised fund is a charitable giving vehicle that allows an individual to deposit funds into a pre-packaged and IRS-approved personal charitable account. By funding the account, with securities or cash, a donor can take an immediate tax deduction. There are other benefits. Securities are put into the account at fair market value, but any appreciation of the securities within the fund’s account avoids long-term capital gains taxes.

Fidelity – and the other big name donor-advised funds like Vanguard Charitable and Schwab Charitable – generally charge 0.6% in an annual administrative fees, but that fee declines to 0.15% for assets above $5 million. The funds in the account are then invested in select mutual funds with their own layer of fees, sometimes as low as 0.07% for a total market index, but sometimes rising to 1.15% for, say, an international equity fund. There the assets remain until dispersed tax-freeto a non-profit, at the donor’s leisure and preferred time-frame.

In other words: take your tax deduction now but pay your charitable bill later. Such features ideally suit a time when top income tax rates were bumped to 39.6% and the top capital gains rate, with the new Medicare charge, went to 23.8%. Research conducted by the Urban Institute and the Tax Policy Center estimates a 1.3% increase last year in total charitable giving, or $3.3 billion more in additional funds, came from the partial resolution of the fiscal discussion and the raising of taxes.

The principle behind this charitable flow – the instinct to move funds out of the taxable pile – seems to be continuing unabated this year. Coupled to the 33% increase in charitable grants made by Fidelity’s philanthropic-minded customers, the fund firm is seeing a 50% spike in $1 million-plus grants. The huge inflows from last year will likely result in continued distributions for the rest of this year, says Sarah Libbey, President of Fidelity Charitable, with grants probably hitting the $1 billion mark by the week ending July 21st.

Also contributing to the big spike in distributions this year is, of course, the stock market’s 18% run-up to-date. In 2008, Libbey says, clients were trying to maintain the same level of grant activity while their stock portfolios were plummeting; they ultimately had to cut back on their generosity. Now, she says, “clients have a renewed confidence that correlates with the uptick in the stock market.”

Fidelity further reports a 43% increase in new accounts compared to the same six-month period last year. It’s interesting to note that wealth advisors are driving the new business: more than 70% of the donor-fund contributions and 60% of the new accounts are attributed to an advisor.

“If we can save our clients tax dollars, by giving them a better bang for their charitable buck, we’re going to use them,” says Chris Roe, of Waldron Wealth Management, a firm with $850 million in assets under management.

Donor-advised funds run by low-cost operators like Vanguard or Schwab have other virtues. The administrative burdens of running a private foundation can be cumbersome, even when coupled with modestly-priced back-office support, as offered by Foundation Source.

Since donor-advised funds are structured as independent public charities, they have greater tax-deduction benefits. When depositing securities in a donor-advised fund, an individual can deduct the gift, up to 30% of their adjusted gross income; that compares favorably to the 20% adjusted gross income deduction allowed for private foundations. It’s even sweeter with cash: individuals can realize a 50% deduction on their adjusted gross income, versus a 30% deduction for private foundations.

“Some clients just don’t feel wealthy enough [to run their own foundation] and don’t need the administrative hassle,” says Roe.

The downside? A private foundation allows a family to more completely control the way its dollars are distributed and invested, and it provides more direct influence on how a non-profit organization spends the family’s largesse. Donor-advised funds also have some legal limitations. They cannot, for example, fund individuals, such as a scientist performing cutting-edge medical research.

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JULY 18, 2013 10:10 A.M.

TiredOfFlippingTheBill wrote:

There is no silver lining to the tax hike. Why would you ever use a fund to give monies to charities. Don't you as a donor want to know in advance of the donation where the money goes? Don't you want to find out what percent is actual used for charity? This is the lazy man's way (or the I don't really give a damn way) to donate to charity.

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About Penta

Written with Barron’s wit and often contrarian perspective, Penta provides the affluent with advice on how to navigate the world of wealth management, how to make savvy acquisitions ranging from vintage watches to second homes, and how to smartly manage family dynamics.

Richard C. Morais, Penta’s editor, was Forbes magazine’s longest serving foreign correspondent, has won multiple Business Journalist Of The Year Awards, and is the author of two novels: The Hundred-Foot Journey and Buddhaland, Brooklyn. Robert Milburn is Penta’s reporter, both online and for the quarterly magazine. He reviews everything from family office regulations to obscure jazz recordings.